Market Equilibrium
It is a position of balance between D and S
It occurs when Qd = Qs
Point of equilibrium is where the S curve and D curve intersect - Pe and Qe
A Shift occurs whether any of the Non-price determinants of D or S change = excess D or S = a new market equilibrium
Surplus
Shortage
If P is smaller than Pe = excess supply
It occurs in:
A Free, competitive market - where there is no interference with the forces of P and Q
If there is a shortage, the excess demand will ensure P increases until Pe
If there is a Surplus, the excess Supply will ensure P decreases until Pe
The price mechanisms
Allocation of resources
If P is larger than Pe - excess demand
Rationing
Signaling function: When there is a shortage due to a movement of D1 to D2, P will automatically begin to increase acting as a signal to firms that there is a shortage.
Incentive function
Surplus
Consumer Surplus
The benefit received by consumers who buy a good at a lower price than the price they are willing to pay = the are UNDER the D curve until the Pe.
Producer Surplus
The benefit received by producers who sell a good at a higher price than the price they are willing to receive = the area ABOVE the supply curve up to the Pe.
Social Surplus
The sum of producer and consumer surplus
.
Marginal Benefits
The extra benefit to consumers from buying additional goods equal to the D curve
Marginal Costs
The extra costs to producers of producing additional units equal to the supply curve
Allocative Efficiency
The best allocation of resources from society's POV at competitive equilibrium = where social surplus is maximised (Marginal Benefit = Marginal Cost)
Society must make choices on how to best allocate resources in order to avoid 'resource waste'
The choice refers to the basic economic problem = what to produce and how to produce
Every choice involves an opportunity cost